Earlier this week, as the price of a barrel of Brent crude hit a four-year high of over USD82pb (see chart), US President Donald Trump claimed at the UN General Assembly that: “Opec and Opec nations are as usual ripping off the rest of the world…”. Determining whether Mr Trump’s remarks are justified relative to what would be a ‘fair’ price for oil would be an enormously complex task — and ultimately, in my view, otiose. But it is worth considering whether the US President is justified in blaming Opec for the USD10pb uptick we have seen since as recently as 17 August; or whether he should really be pointing the finger of blame at himself.
Let’s start with Opec.
Earlier this month, an Opec/non-Opec panel known as the Joint Technical Committee (JTC) devoted a good deal of time and effort to discussing how to reallocate quotas in the wake of a decision in June by Opec members, Russia and others to raise output (without, it must be said, specifying by how much). I think it would be fair to say that, with output down in both Libya and Venezuela and with the US set increasingly to tighten the screw on Iran (much more on which below), most commentators expected an increase deal to be finalised. However, when ministers met in Algiers on 23 September to consider the JTC’s recommendations, no such agreement emerged. Quite why this was is not clear. But my own best guess is that Saudi Arabia ultimately came down on the side of supporting a higher oil price for its own domestic reasons rather than bending to US pressure too keep the price lower, even though this would presumably further hurt Iran (which strongly opposed an increase and may have been backed, again for its own reasons, by Russia).
To an extent therefore, Mr Trump appears to have a point, ie an increase in total output of 500,000bpd, which was reportedly discussed, would likely have eased prices a little; whereas the failure to reach agreement was certainly the proximate cause of the four-year high. However, the key word here is ‘proximate’ when we also need to look at underlying causes.
Go back far enough, of course, ie to 30 November 2016 when Brent was below USD50pb and Opec and Russia struck what was then seen as a surprise deal to cut output, and one can reasonably claim that Opec has been significantly instrumental in pushing up the price — especially as these cuts were later extended through to the end of this year.
Nevertheless, my personal view remains firmly that we saw a watershed moment in the price action, which has nothing to do with Opec, on 8 May when Mr Trump announced that he was withdrawing the US from the Joint Comprehensive Plan of Action (JCPOA) with Iran. Prior to this announcement, oil prices had actually tended to go down since the start of the year (Brent reaching a low of USD62.59 on 12 February notably). However, on 28 April, anticipating the US President’s decision, I wrote as follows.
“Then on 23 April we saw a YTD closing high of USD74.71pb (having briefly topped USD75pb during the day), ie an increase of better than 20% in just ten weeks. Furthermore, this was the highest level at which we had seen Brent since the big sell-off triggered by Saudi Arabia’s blocking of any cuts in output at the 27 November 2014 Opec Ordinary Meeting. Compare this to 2017 when a rise of around 20% took pretty much the whole year! Most oil experts seem to agree that the broad upward trend in the price since mid-February is in significant part thanks to a tightening in the market….”
So far, so good. But, as I went on to explain, fluctuations in the price of oil were already providing compelling evidence to the effect that Mr Trump himself was having an impact. On the one hand, concern over China/US trade relations had already shown a capacity to soften the oil price (notably between 29 March and 6 April when we saw a trade rhetoric-related slide of over USD3pb). On the other, the 22 March appointment of John Bolton as National Security Advisor had immediately hiked the price by USD1.50pb over concerns about what this meant for US policy vis à vis Iran.
This latter move was referred to by Bloomberg as the “Bolton premium”. But, as I argued at the time, I think that this moniker fails to give the President the credit (blame?) he deserves; and that it should more rightly be called the ‘POTUS premium’. I put this at USD3-5pb then and would argue that it is certainly higher still today — maybe USD5-7pb. Furthermore, even though the trade war rhetoric has now become a trade war reality and we did see a sharp dip to USD71.81pb in early August, I see nothing in the price today which suggests that investors believe that Mr Trump’s economic nationalism is about to have a significant negative impact on demand for oil (though this could, of course, change if, as seems likely, he follows through on his threat of yet more tariffs against China).
Given this context, it is hardly surprising that at least a majority of experts see pressure on the current price significantly skewed to the upside (though some question forecasts by the likes of the major commodities trader, Trafigura, of over USD100pb by early 2019). After all, it appears that the Trump Administration is determined to squeeze as much Iranian oil out of the market as it possibly can and that it likely will, therefore, impose secondary sanctions on any country which does not bend to its will no later than 4 November.
How successful the US will be remains to be seen. Notably, China, Turkey and (probably) India, three of Iran’s most important customers, look set to defy the US; and the EU is working on ways round the secondary sanctions threat in its efforts to keep the JCPOA alive. But expert assessments I have seen still put Iran’s likely loss of international sales at around 1.5mbpd — of which Saudi Arabia, which alone with Russia has anything much by way of surplus capacity at present, could probably make up no more than 350,000bpd in the short- to medium-term.
In short, therefore, between now and year-end Brent seems far more likely to be heading towards, and even beyond, USD90pb than back towards USD70pb.
To some, this may seem like no big deal — especially when one considers the nigh-on four year period up until the fateful November 2014 Opec meeting when the world dealt pretty well with Brent at USD100pb-plus. However, although underlining that it does not see a present trend in oil as “a harbinger of doom”, an excellent article in The Economist this week (subscriber access only) does spell out clearly why this move is particularly ill-timed for net energy importing Emerging Markets especially.
It is worth quoting from at some length, as follows.
“Growth in world trade is slowing. Manufacturing export orders flipped from growth to contraction over the summer. As trade growth slows, the adjustment that oil importers must make to higher oil prices becomes more severe. India’s current-account deficit continues to swell, for instance, even as the rupee plumbs record lows against the dollar. Falling currencies exacerbate the burden of dollar-denominated debt. In recent years, companies in emerging economies embarked on a dollar borrowing spree, lured by low interest rates. For companies that earn in their domestic currencies but owe in dollars, the depreciations which ease the adjustment to dearer oil prices mean a financial squeeze. Indebted corporate borrowers may curtail investment and hiring, or even default. One economic drag reinforces another.
Unluckily, oil prices are rising just as global financial conditions are also becoming less forgiving. Rich-world central banks, on high alert for signs of accelerating inflation, are moving towards a tighter monetary stance. When America’s Federal Reserve raised its benchmark interest rate by another 25 basis points, to 2-2.25%, on September 26th, it reiterated that further rises were on the way. Rising rates in America act as a magnet for global capital, buoying the dollar and sponging up money which previously sought out high returns in emerging markets.
In the early 2010s the Fed stayed doveish despite high oil prices, recognising that high unemployment would keep inflation in check. With joblessness now below 4%, the hawks are poised. Higher energy prices may well mean faster interest-rate increases and more pressure still on the current accounts of beleaguered emerging economies.”
As for Mr Trump, he may well have chosen 4 November for the next wave of sanctions against Iran in part at least to try to fire up his base — the evangelicals especially — to go out and vote in the 6 November midterms. However, in so doing he may also have created a two-edged sword by pushing up politically highly sensitive gasoline prices at the pump. Much as he will no doubt continue to point the finger at Opec, at the margin at least this is another cross for his already struggling party to bear — and one which could yet prove telling in tight races in the form of a(nother) POTUS premium for the Democrats.